Grantor Retained Annuity Trust
Transfer Growth, Keep the Annuity

The basic idea

You create an irrevocable trust and transfer assets into it: stocks, real estate, business interests, whatever you expect to grow in value. In return, the trust pays you a fixed annuity every year for a set number of years (the “term”). When the term ends, whatever is left in the trust goes to your beneficiaries.

Here’s why it works: the IRS measures the gift you’ve made based on a benchmark interest rate (called the §7520 rate). If your assets grow faster than that rate, the excess is what passes to your heirs, and it’s not subject to gift or estate tax. The annuity payments return a portion of the value to you, so the taxable “gift” is very small (often close to zero).

The IRS hurdle rate

Every month the IRS publishes the §7520 rate, which is tied to federal interest rates. This rate is the GRAT’s hurdle: your assets need to grow faster than this rate for the GRAT to transfer wealth. Any growth above the hurdle passes tax-free to your heirs. Growth below the hurdle just comes back to you as annuity payments; you haven’t lost anything.

When interest rates are low, the hurdle is lower and GRATs are more powerful. But even in higher-rate environments, a GRAT can work well if you’re funding it with assets that have strong appreciation potential.

What assets work best

GRATs are most effective with assets you expect to appreciate significantly:

• Concentrated stock positions: shares in a company you believe will grow
• Pre-IPO or pre-liquidity event shares: the classic GRAT candidate
• Real estate expected to appreciate: particularly development-stage or undervalued properties
• Closely held business interests: especially if you expect growth or a future sale

Assets that produce steady but modest income (like bonds or stable dividend stocks) generally aren’t ideal; they’re unlikely to beat the hurdle rate by enough to make the GRAT worthwhile.

The “zeroed-out” GRAT

In most cases, the annuity is set high enough that the value of your retained annuity nearly equals the value of what you put in. That makes the taxable gift of the remainder interest close to zero, meaning little or no gift tax, and little or no use of your lifetime exemption. This is called a “zeroed-out” GRAT, and it’s the standard structure.

You still report the transfer on a gift tax return (Form 709), but the gift amount is typically very small.

The catch: you have to outlive the term

If you die during the GRAT term, the estate planning benefit is lost. The trust assets (or a portion of them) are pulled back into your taxable estate, as if the GRAT had never been created. You don’t lose the assets, they go to your estate and then to your heirs through your will or revocable trust, but you don’t get the transfer tax savings.

This is the GRAT’s main risk, and it’s manageable. The solution is to use short terms.

Rolling GRATs: managing the risk

Instead of one long-term GRAT (say 10 years), many people use a series of short-term GRATs, often two years each. When the first one ends, the annuity payments fund the next one. This approach:

• Reduces mortality risk: you only need to survive two years at a time
• Captures volatility: a big gain in any one window transfers significant wealth
• Lets you reset the hurdle rate with each new GRAT
• Gives you flexibility to stop creating new GRATs if your circumstances change

Taxes during the GRAT term

During the term, the GRAT is a “grantor trust,” which means you, not the trust, pay income tax on all the trust’s earnings. This sounds like a downside, but it’s actually a benefit: your payment of the income tax is not treated as an additional gift. The trust assets grow without any income tax drag, which means more passes to your heirs at the end of the term.

The trust still files an informational tax return, but no tax is owed at the trust level.

When the term ends

At the end of the term, the remaining trust assets pass to your beneficiaries. Depending on how the trust was drafted, the assets might go directly to your children, or they might stay in a continuing trust for their benefit. Either way, the GRAT’s job is done; the appreciation has been transferred.

One important note: the beneficiaries take a carryover basis in the assets, not a stepped-up basis. They inherit the trust’s basis, which is generally the value at the time you funded the GRAT. When they eventually sell, their gain is measured from that original basis. This is different from assets inherited at death, which get a step-up.

When a GRAT makes sense

• You have assets you expect to appreciate significantly over the next few years
• You’re in good health and expect to outlive the GRAT term
• You want to transfer wealth to the next generation but don’t want to use up your lifetime gift tax exemption
• You’re comfortable with the assets being in an irrevocable trust (you can’t take them back once the GRAT is funded, other than through the annuity payments)

When it might not be the right fit

• Your assets produce steady income but aren’t expected to appreciate significantly
• You have health concerns that make outliving the term uncertain
• You might need the assets back for living expenses (the annuity is fixed; you can’t get more)
• Your estate is below the estate tax exemption and transfer tax planning isn’t a priority

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